In other words, there's no "silver bullet", no matter the industry. I also think that we should stop believing in the "wonder" of compound interest and act accordingly, because it will come a time when this "wonder" will prove to be just that: a thing that cannot last forever. The same goes for a guaranteed rate of return on investment.
Seriously. Sometimes I wonder about who actually is visiting this site.
The 'wonder' of compounding interest?
It's merely the monetary representation of the return on investment in productive activities and assets. The reason money has a cost is because it can be converted into useful, productive activities, so the holder needs to be compensated for that.
The 'wonder' is how animal herds and horticulural products increase enough in quantity to feed us all.
Building a shelter over your head is compounding interest at work. You sleep better, stay healthier and have more time to do other things. Same goes for a knife or a spear, or a factory or a computer.
I find it incredibly odd that we have people running around saying 'we have to stop growth' 'growth is bad'. Yet, on all measurable criteria - every single one of them - things keep getting better. This is because of the compouding effect of investment in knowledge and productive capacity.
I'm not sure where the growth-hate comes from, if it is ignorance or just some sort of strange moral fashion to hate on the modern world. Either way, a class of people have convinced themselves that - of the entire trajectory of growth from nomadic paleoithic peoples to now - it's right at this point the wheels are about to fall off. Strikes me as a little narcissistic, really.
> Seriously. Sometimes I wonder about who actually is visiting this site.
I'm a programmer who sometimes reads about economics and economics history. I've also worked in some finance-related industry for a couple of years early in my career (in the IT department).
> This is because of the compouding effect of investment in knowledge and productive capacity.
Yes, I know how compound interest presently works, I was just questioning its long-term (think 50-to-100 years, if not more) viability. To give an example which I stole from people smarter than me, just think that if you had invested your pension money on the Russian stock market in the 1910s or on the Chinese stock market in the 1930s you would most probably be bust (to say nothing of nationalizations and confiscations of private real estate). And these are two pretty big examples which happened in the last 100 years.
The idea that the return on the rate on investment on the long term can only go down I've stolen from Jean-Baptiste Say, who wrote it down in the ~1820s. Now, he just happened to write this before the Industrial Revolution started doing its thing and, just as important, before economic colonialism started to positively influence the Western economies of that time (think the Opium Wars). Now, you're saying that we'll be able to somehow reproduce that Industrial Revolution a second time, I question that optimism.
> I'm not sure where the growth-hate comes from
I'm not at all "hating growth" (even though I believe that we should be well aware of its downsides). I'm just saying that it's no good making only positive economic projections about the future, we're not magicians and crystal balls are just that, pieces of glass.
If your here to quote Says law then you have my support. But while growth in specific investments must always stop, eventually, aggregate growth will continue unless people opt for a lower standard of living.
It's easy to look at a particular assets class - say railways- and show zero return over a long period. But looking at all improvements across all industries shows growth is always coming from breakthroughs somewhere. Healthcare, rocket science, these are two major fields wher rapid change is evident, even if it is of the incremental kind.
I think you've mixed up the concept of compounding interest and specific assets classes ability to return positive and withstand time. They are really two separate topics.
Capital could never be directly translated into power. Capital always had to be used to buy enough people who combined had power. Those people could refuse to be bought and instead join those without capital on moral reasons. Even as technology allowed us to use capital to increase the power of a small group of people, there still had to be a small group of people.
But we are soon to hit a point where capital will be used to buy power directly thanks to advances in AI and robotics. We may never again have another cycle like you describe.
To be honest, I fear this, because I consider it likely enough to fear, but I don't think it's the most likely outcome by a big margin.
If you want to know the probable outcome of an Intelligent Capital vs. The People fight, just look how a big company defends its computer network against targeted hackers today.
I think the point the parent is getting at is that nothing about business guarantees constant, compounding growth. It's not just mathematics, it's population growth, productivity, capital distribution, etc. - lots of stuff that we take for granted that results in constant growth rates, but that doesn't necessarily have to.
Compounding interest could continue at the upper right part of the S-surve. If the interest decreases every year, and sufficiently fast, it could give rise to a convergent infinite product. So total wealth would never exceed the threshold of the possible.
As far as I've read "index tracking" is seen as this wonderful thing that cannot go wrong. Until it does. It's another way of saying "this time is different".
The last part of my comment is related to the fact that "index tracking" and all the related "investment strategies" rely on the assumption that, over all, things will only go up, i.e. ROI will always be positive. I questioned that assumption. We cannot guarantee that in 30 years' time (let's say) we will still be able to return 3-5% on our huge piles of pension funds' money, no matter the strategy. What I'm saying is that we should be prepared for a stagnating or even deflationary world, financially and economically speaking
It's almost entirely about paying less in fund fees and aiming to be 'average'. I.E. get the return of the market rather than trying to beat it. Think of it as 'passive' investing rather than index investing.
EDIT: But yes, we don't know whether one can assume "The S&P500 will average 10% per year for EVARRRRR!!!1".
I'm not the OP or the grandparent post, but I wonder what happens if a significant portion of the market starts indexing? My gut is that there are strong incentives against that: as more people start indexing, the gains from not indexing become more diverse.
You realize that the scenario you describe is equivalent to "the entire collapse of global civilization that will make previous dark ages look like candy and unicorns."
I'm serious. If the overall economy is "stagnating or even deflationary" for any significant period of time, all of the wheels are going to come off.
(Really want a dark thought? You realize that we've dug up and used all of the easily-available oil, right? When Some Later Generation Gets Its Act Together, they aren't going to have a convenient, cheap source of energy.)
Yes, parent poster said that index funds "seen as this wonderful thing that cannot go wrong." But nobody who knows anything about investing sees them that way. Index funds invest in stocks and bonds, a broad index fund will pretty much mirror the market. But the market, even the market as a whole, is far from safe.
What an index fund does guarantee is that holders of the fund will do better than the average of the "active" investors, who try to pick and choose the best stocks in the index (which for a broad index is basically "the market"). This is because the active investors, as a whole, receive the "market return", but they do so only after investing resources in researching the companies (which index funds don't do) and because the active investors trade a lot, relative to the index fund, so the active investors incur much greater transaction costs. An index gets the market return, but without incurring the costs active investors do, so the index is certain to have a better net return than the average of all active investors. This doesn't mean that index funds are "a wonderful thing that can never go wrong". It's certainly possible for the market to tank, in which case it's little solace for index fund holders that they beat the performance of the average active investor.
> (Really want a dark thought? You realize that we've dug up and used all of the easily-available oil, right? When Some Later Generation Gets Its Act Together, they aren't going to have a convenient, cheap source of energy.)
Plenty of nuclear fuel still around, on earth (uranium, thorium, hydrogen) and in the sun (solar power, wind, etc).
Digitized data is replacing physical storage, and that makes it ephemeral.
How would you read a DVD without a player? Can you rebuild the player, without specs? Can you rebuild the filesystem, or the decoding?
There is plenty of cheap energy that isn't oil--unfortunately, the exploitation of it without oil reserves to bootstrap with may prove impossible. That's the point being made here.
I would argue that while information can't die, expertise and built up production capacity certainly can, and I think that's even more important. I could read all the books I wanted about how to build a plane, but I highly doubt that I'd have the first clue where to start.
Medieval villages didn't use oil either. Have to get past that point. Have some oil-seed crop, sufficient population, trade with large cities. Then - buy antique samples of thorium and uranium, put in a pot - they melt and give off heat. Not too complicated really.
Like @kspaans says it's more about buying a representation of the market i.e. passive investing. Though, in the case of the S&P500, 500 large cap US stocks is hardly buying the market, so a keen investor would try to create a truly diversified portfolio including domestic, international, equities, bonds, real estate, commodities, etc.
